For investors, there’s no better feeling than seeing a company’s shares skyrocket from a takeover offer. And for the acquiring company, optimism tends to spring eternal on such announcements as they anticipate a brighter future – and a higher share price. The reality? Despite the best laid plans, most mergers and acquisitions (M&As) ultimately fail.
Professors Baruch Lev and Feng Gu, authors of The M&A Failure Trap: Why Most Mergers and Acquisitions Fail and How the Few Succeed, analyzed 40,000 acquisitions over four decades and have found that a staggering 70-75% of M&A transactions either failed to achieve their stated objectives or were cancelled before all approvals were completed.
The reality is that the announcement of an M&A deal is just the beginning. Shareholder votes, regulator approvals, and competition bureau rulings are just a few of the hurdles that can stretch out the process for months – or even years – before the merger is potentially approved. And if the deal is complete, the real test then begins as the two companies integrate their operations, cultures, and strategies.
Learning from an epic fail
For many, the merger of AOL and Time Warner stands out as the poster child for M&A gone wrong. In January 2000, the companies announced a mega deal that would combine AOL’s dominance in internet search and email with Time Warner’s vast media and entertainment business. The deal was valued at an eye-watering $350B U.S. and hailed as brilliant at the time – old economy meets new. But in 2002, just two years later, the combined company took a $99B goodwill write-down. AOL was spun off from Time Warner in 2009 and later acquired by Verizon for $4.4B in 2015 – a far cry from AOL’s $222B peak market cap in late 1999.
There are many reasons why mergers fail but three key ones doomed the AOL-Time Warner merger, all which remain critical lessons for investors today:
- Culture Clash. Time Warner had a more traditional corporate culture versus the aggressive start-up type culture of AOL. Distrust and lack of cooperation made integration extremely difficult.
- Lack of Innovation. Executing a merger of this scale is a massive undertaking that can draw significant resources. AOL was the leader in dial-up internet, which was dominant when the merger was announced. Four short years later, cable broadband had surpassed dial-up in U.S. households. Resources consumed by integration may have distracted AOL from pivoting into new technologies.
- Overpaying. Perhaps the biggest reason for M&A failure is paying too much. AOL used its inflated dot-com bubble era stock price to buy Time Warner’s strong assets. Shareholders of the latter suffered as AOL’s business model quickly deteriorated.
For investors, the lesson is clear: even the most celebrated deals can destroy value if management overestimates synergies, underestimates cultural differences, ignores changing industry dynamics, or overpays.
Roll-up to win
The AOL-Time Warner merger was a massive deal between two very different companies operating in different industries (content and the internet) that were converging but weren’t quite there yet. The execution of this merger was always going to be a herculean task that would have required incredible vision and planning. While large, cross-industry mergers often stumble, a different acquisition strategy has produced some of Canada’s biggest corporate success stories: the roll-up strategy.
Unlike mega-mergers in different industries, roll-ups focus on growth by acquiring smaller firms within the same industry to achieve scale, reduce competition, expand geographically and boost profitability.
Stantec, TFI International, The Boyd Group, Constellation Software and CGI are all examples of Canadian companies pursuing successful roll-up strategies. Though these companies are quite diverse, they all started with one key similarity: a fragmented industry. A company that can execute roll-up strategies just gets better with time. Practise makes perfect and as the company gains more experience in M&A deals, the learnings multiply. A great Canadian company that has illustrated the power of the roll-up strategy over the past three decades is Alimentation Couche-Tard.
From a single store in 1980, Couche-Tard has grown into a global operator of nearly 17,000 Convenience stores. In North America, it primarily operates under the Circle K banner. Its acquisitions have included single stores, small tuck-ins, medium-sized chains, divestitures from big oil and multi-billion-dollar corporate companies. Along the way, the company honed its integration process, retained key talent, incorporated ideas from acquired firms and realized synergies in merchandising while increasing purchasing power.
“Management teams with a proven track record of driving success out of acquisitions can be a great source of returns for any portfolio.”
The results speak for themselves. A $100 investment in Couche-Tard at the end of 1997 is worth over $28,000 today! (see figure 1)
Due diligence is everything
Whether at the corporate or investor level, due diligence separates success from failure. Companies that thrive at M&As approach them with intention, rigorous analysis, and a clear plan for integration. As investors, we must take the same approach. A management team with a proven record of successful acquisitions deserves our attention, but every deal must still be evaluated on its own merits. Past performance does not guarantee future success, but it can give an investor a great signal of where to look.
In that vein, I’d be remiss if I didn’t comment on our merger with National Bank of Canada. From my point of view, this has all the characteristics of a successful roll-up type acquisition. Two companies with similar cultures operating in the same industry, focusing on collaboration in the integration to seize on best practices with emphasis on retaining top talent. Although M&As bring a lot of change for employees and clients, if done properly, 1 +1 can certainly bring more than 2 to all involved. I’m excited for this next chapter with our advisors and clients at National Bank Financial. Together, we’ll continue delivering the investment solutions and insights that have guided us well for years.
Sources: FactSet, Fortune
Scott Blair, CFA
Head Portfolio Manager
